Weekly Review: Risk Growing

The past week was highlighted by the “perfection” of a TD Sell Setup on the weekly chart when we exceeded the 930.17 level. When a Setup is perfected there is a possibility that the current trend in force (in this case the rally from the March low) has become “exhausted”. Such exhaustion will usually manifest itself within a few price bars and may be just a pullback / consolidation (before the market continues its outstanding trend) or it may mark a trend reversal. One way I like to distinguish between the two possibilities is by using two indicators: Welles Wilder’s RSI and Connie Brown’s Composite.

This week we note that although the RSI (top pane) has confirmed the new price high by making a new high itself, the Composite Index (middle pane) is lagging. This is *potential* bearish divergence between the two indicators. The RSI would have to turn down (which would require price to turn down) from here to trigger the actual “sell” signal. Without a signal I favor the pullback / consolidation view. With a signal I would favor a much deeper retracement (move lower). In either event the current upside potential is quite limited (968-973) while downside risk is growing (max would be a retest of the March lows if a weekly “sell” signal is generated). Therefore I would not be a new buyer of equities here and I would protect any existing positions with tight stops. In fact, someone who was thinking “I wish I had sold my stocks” last autumn or early this year may now be looking at a good time to do so (if we get the weekly signal).

Of note in the coming week is the position of the upward sloping dashed green line. This line has served as a good proxy for the “demand” of equities over the past few weeks and is why Tom DeMark (TD) labeled it as the Demand Line. It sits at 948.42 next week while we closed this past week at 940.09. This sets up the likelihood that we will break below this line (quite possibly right at the open on Monday) -- which should be viewed as another sign of weakness.

Bottom Line: Upside potential is limited over the next few weeks while downside risk grows. Price action on the daily chart over the coming days should provide a good idea of whether we consolidate / pullback a bit from these levels or experience a much deeper retracement of the move up from March.